SA Listed Property Update: According To The Professionals

In this week’s article, I take a look at four investment houses (Discovery Invest, Nedgroup, PSG and Sesfikile) and their views of the local listed property market, reveal what the investment or research teams are focused on, and which stocks they are interested in as well as the counters they are avoiding.

Market conditions and outlook according to the professionals

South African listed property, as measured by the SA Listed Property Index, is approximately half a trillion rand in size. Combing through the various investment options is becoming an increasingly tougher task. Our local politics, poor economic growth and various other concerns add to this difficulty. So what exactly are the professionals saying about the current market and where we may be headed?

Neil-Stuart Findlay of Discovery’s Flexible Property Fund:

"Whilst it could be argued that the domestic and, in some cases, global real estate backdrop has become more challenging of late, we are encouraged by the continued flow of good investment opportunities we see within the locally listed real estate sector. Indeed, we believe that this is an environment in which active stock pickers can add significant value.

Specifically, when assessing stock risks, it is key to have a carefully constructed and repeatable framework in order to avoid what can amount to sizable pitfalls in the current volatile economic and political climate. Although we continue to see attractive returns from the sector, we believe there will be an increasing discrepancy between the winners and losers."

"Stocks with operations in the UK, such as Intu and Capco, have been adversely impacted by the uncertainty regarding the UK’s economic growth prospects post Brexit. The fund has used the weakness in the UK property market to gain access to quality assets at discounts to NAV.

The sector still trades at a near record low dividend yield even as the quality of dividends has deteriorated substantially. We remain concerned that property investors are paying for non-recurring income streams as if these incomes are perpetual in nature."

PSG Wealth Research Team:

"The lack of local growth has led local property companies to expand offshore, particularly in the Eastern European region. The retail space in the European market has displayed attractive investment fundamentals with low vacancy rates, positive rental renewals and escalations in growth.

Recovery of the office sector is becoming increasingly fragile with high vacancy rates, weak rental renewals, and a slowdown in rental escalations.

The PSG Wealth research team anticipates current lacklustre economic conditions to persist across all sectors. Muted demand, due to depressed confidence, is expected to place further pressure on rentals, while retaining and attracting new rentals will continue to come at a price. Economic conditions and changes in sovereign risk and capital markets are expected to be the main drivers of performance in the property sector over the short term."

Fund manager Team at Sesfikile BCI Property Fund:

"The macro environment has been supportive to our sector and could remain that way into year-end. What has changed is that we are getting closer to the ANC elective conference in December and with it the various stakeholders are positioning themselves for a winner-takes-all scenario.

We think that mid-single digit returns are plausible over the upcoming twelve months, however the path will be highly volatile. The medium to long-term outlook is still settling between 10% and 12%, and ironically enough we have more confidence on the longer term outlook due to the ability to look through the short term noise and rely on the initial forward yield and inflation-linked growth to drive earnings."

What are the professionals looking at?

Discovery’s Flexible Property Fund:

For Discovery Invest, it is all about risk controls. According to the team there, this focus is often underappreciated by investors "until they really count" according to Neil Stuart Findlay (Fund Manager of the Flexible Property Fund). He adds that "The analysis of risk not only helps us to avoid stocks delivering negative surprises, but also aids in the discovery of attractive investment opportunities where the risks are more than discounted by the market."

One of the many risk metrics the team take notice of is Loan To Value (LTV), a ratio of a loan to the value of an asset purchased or put differently, debt expressed as a percentage of the property value held.

PSG Wealth Research Team:

The Research Team at PSG Wealth dedicated several pages of their Winter Strategy and Research Report to the rise of online retail and the threat it yields.

According to the team at PSG, "E-commerce poses a prevalent risk for property companies that have significant exposure to the retail sector. Retail property used to be a highly defensive property type. However, the growth of e-commerce, together with an already constrained consumer, has placed retail space providers under immense pressure.

Hyprop was particularly impacted by the recent closure of Stuttaford stores in three of its malls, leaving about 11,000 m² of vacant space in these retail properties. South African super regional centres have also taken a knock, as large international retailers like Mango and Nine West started to exit the market. Because rentals are a function of retailer turnover, providers of retail space have become more focused on the performance of their tenants."

Source: PSG Research and Strategy Report - Winter 2017

The shares liked by the professionals

So which shares are the unit trust fund managers looking at?

Neil-Stuart Findlay of Discovery’s Flexible Property Fund:

"Amongst the locally-oriented names, Vukile Property Fund is a great example of a company offering a more focused and appealing strategy, an above average yield, accelerating growth prospects and below average balance sheet risk. We believe the company provides investors with the prospect of a material rerating and hence outperformance going forward.

Similarly, MAS Real Estate is an offshore name exhibiting an attractive risk-reward profile, in our view. Through its joint venture with Prime Kapital and its highly experienced, on-the-ground management team, it is best placed to understand the regional risks and opportunities of the Eastern European markets in which it operates. MAS’s medium-term growth prospects are amongst the highest in the sector (a compound annual growth rate of c.30% over the next three years). Furthermore, its premium to NAV is half that of its regional peers (e.g. NEPI Rockcastle), and its balance sheet provides plenty of scope for value-adding expansion going forward."

"The fund maintains a large overweight position in the Rebosis A share as the guaranteed income growth with substantial interest cover remains an attractive value proposition in an expensive market in which income growth is difficult to sustain.

In addition, the fund has exposure to the Fortress A share which exhibits similar attributes. The fund also maintains large overweight positions in stocks such as Octodec Investments and Fairvest that have relied more on fundamental drivers of income growth than on once-off gains.

On the offshore front, the fund has exposure to Capco and to Hammerson REIT."

Sesfikile BCI Property Fund:

Source: August 2017 Sesfikile BCI Property Fund Fact Sheet

The shares the professionals don’t like

It is arguably as important to identify shares that are to be sold or overlooked as it is to uncover the next winner in a portfolio. Here are two views that may help you think twice before hitting that "buy" button.

Discovery’s Flexible Property Fund:

The team at Discovery believe that Accelerate Property Fund’s (APF) strategy is "notably impaired". Neil goes on to explain that "Whilst a development-focused fund can work well in a private environment, it can be highly problematic when too aggressively executed within a real estate investment trust (REIT) structure. Developments by their nature are capital intensive, whilst REITs are compelled to do exactly the opposite - pay out the vast majority of their retained income. This has led to a scenario in which APF’s distribution growth and balance sheet risk have been severely impacted."

APF’s elevated level of balance sheet risk is worrying (LTV of 42%). It is likely that even more capital will need to be raised in order to cover the Fourways Mall development next year. The costs in this case may, according to the Discovery Flexible Property Team, even exceed the initial return on capital.

The tragic news is that this story could go from bad to worse in the view of the investment team... "APF’s heightened cost of equity and rising cost of debt will in our view further dilute both the net asset value and the income of the fund for at least the next 24 months. APF’s share price decline could be compounded further by its possible exclusion from the South African Property Index before year-end. We continue to hold no shares in APF."

The team at Nedgroup Investments are ensuring that they don’t get caught out buying into stocks that are delivering distributable income growth through once-off activities like acquisitions.

The fund manager is of the view that this mispricing will correct in time "as the sector will find it more difficult to generate income through 1.) debt restructuring and 2.) yield enhancing acquisitions over time."

Avoiding the shares that trade at comparable valuations but that are temporarily inflated on the income stream front will, in Shala Ramokolo’s mind, help the fund to outperform over the medium term.

Mark graduated with a Business Science Degree from the University of Cape Town in 2007. He then joined Sharenet, during which time he also completed his B.Com Honours through UNISA. Mark has helped to build, launch and manage derivative and share trading brokerage businesses. He is also a JSE Registered Securities Trader, and has worked on the trading desk at Sharenet. After seven-and-a-half years at Sharenet Mark then moved to Reitway Global (a specialist Global Listed Property Fund Manager) where his passion for property was further kindled. Mark currently works for Discovery Invest as an Investment Specialist on their Investec Managed fund offering. He has over ten years of experience in the equity and asset management sector and can be reached at: markm@discovery.co.za

The views and opinions (where expressed) in this article are those of the author and do not necessarily reflect the official policy or position of Discovery Invest.

Disclaimer:
The information contained in this article is for informational purposes only and must not be regarded as a prospectus for any security, financial product or transaction. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial issue. Investors should consider this research/article as only a single factor in making their investment decision. We recommend you consult a financial planner/advisor to take into account your particular investment objectives, financial situation and individual needs. The views and opinions (where expressed) in this article are those of the author and do not necessarily reflect the official policy or position of Sharenet.

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